Editor’s note: This article was first published in November 2017. The billionaires “over 80 with more than 70 billion” refer to Warren Buffett’s age and fortune then, the 30-year mortgage payment costing about the same as rent reflects the Spanish housing market, and the 17-21% personal loan rates are as of that year.
Unfortunately, financial education isn’t one of the education system’s priorities, so people go out into the world knowing that money is necessary, but it’s a tool few of them know how to use. Others devote their lives to chasing money and lose their health because of it.
In reality, money shouldn’t be an end in life, but a tool that helps us achieve our real goals. The health of our finances sometimes depends less on how much we know about finance and more on our own mindset, our psychology and the way of life we’ve chosen.
In the hope that it helps, here are several key points everyone should know about money.
1. There are no unexpected expenses, only poorly organised finances
Sometimes you’re in a comfortable financial position: month after month your salary comes in, you cover your expenses and there’s even money left over at the end of the month. And suddenly… BAM! The car breaks down, or something at home gets damaged and needs urgent repair.
That’s when we say something unexpected has come up, a surprise expense. It turns our finances upside down, and it can even hit people who had a financial plan.
Well, there are no surprise expenses, only poor financial planning. Surprise expenses aren’t surprises, and you have to allow for them. In other words, if you have a car, you have to assume it may break down and need repairs. If you have a pet, you have to assume it may need to see a vet at some point.
That’s why, first of all, we need what’s known as an emergency fund: basically a sum of money, saved and readily available, that we can draw on for this kind of thing, and even for more serious things, and that would let us get by for at least six months if we lost every source of income today.
Even so, we should include these surprise expenses in our savings plan. That way we’ll budget each month for putting some extra money into the emergency fund, and we’ll avoid spending it on the assumption that our finances are in good shape.
2. “You talk a lot about saving, but what if I can’t save any more from what I earn?”
I’m glad you asked. You can’t get blood out of a stone, that much is obvious. So if we can’t save more money than we need for proper planning and peace of mind about our future lifestyle and unexpected expenses, what’s left? Exactly: earning more money than we earn now.
Finding a way to generate more income may sound complicated at first, but the truth is that these days it isn’t hard to put a skill we have to use, or to set up a small side business that doesn’t even need much investment.
Remember that depending on a single source of income is too dangerous nowadays, because that single source could dry up tomorrow. Your mission in personal finance is to have several income streams. Recently we looked at the case of a woman who had 15 sources of income. We don’t need that many, but if you’ve given any thought to your financial future, you should already be receiving some kind of income from an asset.
3. Which assets generate passive income?
As a general rule, building an asset doesn’t happen quickly. One of my favourites is dividend income from shares, but of course that means investing in shares, so we need to have done some financial planning beforehand to set money aside for investing.
A business selling something, anything. Today it’s easy to sell products without ever handling them and have them delivered straight to the customer’s door. Here we explain how it’s done.
An asset can be a blog, an online store, or a video course that people pay for (there are platforms that pay for this). In this article we explained some ways to generate income from home.
Holding a patent or writing a book are other ways of earning money passively. So is investment property. There are many ways to do it. Find yours and start as soon as possible, until your passive income matches and then exceeds your salary. That way, if one day the unexpected happens and you lose your job, it hurts less.
4. Measure the health of your personal finances. How?
The best question for finding out whether our finances are healthy is how much money we’re receiving without having to work for it. In other words, how much passive income we get from assets. It’s an excellent indicator of how financially free we are.
See also: 3 financial formulas to help you achieve financial freedom
5. No debt, and if it’s already too late, be smart about paying it off
The first principle of personal finance is to steer clear of debt, except in the cases where it’s necessary. In fact, as long as you have debts such as personal loans and credit cards (to name a couple), the best thing you can do is not invest in anything except paying them off, because paying off debt is the best investment you can make.
You’ll rarely find an investment that earns you 17 or 21 percent year after year, and some personal loans carry interest rates like that, so above all, invest in making those debts disappear.
6. Which debts should you pay first: the smallest or the ones with the highest interest?
Good question, because until now we’ve always advised paying off the highest-interest debts first. That’s undoubtedly the right thing to do. However, it’s also been observed that clearing the smallest debts first, regardless of the interest rate working against us, makes people feel more motivated to keep paying off their debt.
In this case, rather than weighing whether to pay the smallest debt or the one with the highest rate first, weigh your own mental strength and commitment to paying off your debts. Personally, I still think you should always tackle the most serious problem first. And the most serious problem in our finances is a very high interest rate working against us. Go after that first (in my opinion).
7. The only point of earning more money is to invest it
There’s no sense in saving for the sake of saving, not least because over the long term inflation would eat away part of our savings. In a way, it’s like having an interest rate working against you. We should invest our money according to our investor profile and experience.
If equities (the stock market) scare you, at least try to put your money into savings accounts that pay you a return, bonds or fixed-term deposits. Whatever your age, we should be harnessing the magic of compound interest to multiply our savings.
We wrote an article explaining how surprisingly compound interest works: basically, you keep adding the gains to the principal and reinvesting them.
For those who want to retire rich, how much you need to save each month will depend on the age at which you start investing and the return you get each year on your money, which you then reinvest. To give you an idea, a 25-year-old would only need to save 499 euros a month to retire with more than 1 million euros (earning a 6% annual return on their money).
Put another way, thanks to compound interest, your first €361 saved at age 20 turns into €5,336 by age 65.
Knowing how this works, you may not want to wait until 65 to have 1 million euros; you may want it by 40. In that case, all you need to do is set a goal and work out how much you need to save to reach it (it won’t be easy, but it’s not impossible either), and often that’s achieved by starting your own business. It will be hard to reach that kind of money working for someone else.
8. But money shouldn’t be an end in itself, just a tool for getting what you want
Wanting to make money for the sake of making money and being rich isn’t a purpose in life. In fact, you’re unlikely to achieve it if making money is your only aim. If there’s one thing we’ve learned by now from studying the lives and careers of hundreds of very successful entrepreneurs, it’s that their goal wasn’t to become millionaires but to build something great, leave a legacy, change the world and improve other people’s lives.
And if you manage to improve many people’s lives, that has its rewards. As Walt Disney put it: “We don’t make movies to make money, we make money to make more movies.”
Richard Branson often says that if all you do in life is make money, or if all your company does is make money, you’re in a bad business. Perhaps all this answers the question of why billionaires over 80 with more than 70 billion still get up every morning to go to work. The answer is that the passion that gets them out of bed to go to work, even with a fortune of 70 billion, is what earned them those 70 billion in the first place. And that passion is what you’ll need, far more than the desire to make money.
9. The best investment you can make is in yourself
Warren Buffett agrees with many other investors and entrepreneurs that the most profitable investment is cultivating your own mind, because your mind is your best asset.
Never think of money you invest in learning as an expense, whether it goes on books or on courses that help you grow and gain knowledge. If you want to achieve what others have achieved, you’ll have to do what they did, and it so happens that most successful people count reading among their habits. Bear in mind that a book can give you a person’s lifetime of knowledge condensed into 300 pages, which is a shortcut to success in any field.
If you want to be an excellent salesperson, read everything you can by the best salespeople. If you want to be a great entrepreneur, devour the books of great entrepreneurs. And if you want to be a good investor and understand how money and investing work, devour books on finance and financial education.
See also: The 13 best books on finance and the stock market of all time
10. Want to make sure your pockets stay empty?
There are several ways to guarantee empty pockets:
The first is borrowing money to buy an asset that depreciates. In plainer language: taking out a loan to buy a car you can’t really afford.
The trouble starts the moment we stop telling wants from needs. This is a subject we’ve covered many times, because, as we often say, financial education sometimes has less to do with money than with our state of mind. If you need a luxury car because you feel the need to impress or keep up appearances, your problem goes beyond finance, and it will also land you in financial trouble, because in this case a car is a fully depreciating asset that we could consider one of the worst investments you’ll ever make. It’s a different matter if it’s a work tool.
Here we explain why buying a second-hand car is a better option than buying a new one. We’re using the car as an example, but we make the same mistakes with furniture, home decor, clothes, accessories and gadgets.
The best way to guarantee empty pockets is to travel every chance you get. I can’t remember who said this, and it needs to be read very carefully, because travel is generally recommended as a way to gain experiences and open our minds to other cultures. Sadly, these days people travel more because Facebook and Instagram exist. I honestly believe that if they couldn’t post their holiday photos on Facebook, they wouldn’t travel nearly as much. Seriously, there are even studies on this.
It’s also true that other people travel often to get away from work, stress and so on. Some people suggest that it might be better to build a life you don’t need to escape from. Unless, of course, you’re like the couple we wrote about who earn up to $9,000 per post on their Instagram account.
11. Rent or buy a home?
From a financial point of view, our advice to a young person is that the later they take on a mortgage, the better, because a mortgage could wipe out their ability to save. What’s more, owning a home can make someone stop considering moving to another city for a better job. In a sense, renting gives you mobility and doesn’t leave you feeling tied down.
In any case, given that a 30-year mortgage payment now costs about the same as rent, each case needs to be looked at individually. But we should be very clear that buying a home to live in isn’t investing in real estate. We can say we’re investing in real estate when we buy a property in order to earn a return on it, and for that we need to analyse the payback period, the time it takes to recover the investment.
If the payback period is going to be around 30 or 40 years, it’s hardly the best investment we could make, because we have to allow for risks that may come up along the way. But if the payback is going to be around 10 or 12 years, we could be talking about an excellent investment.
That said, as we mentioned at the start, many other factors need to be analysed, such as rising prices for the asset or the possibility of it gaining value for other reasons.
If you do choose to take out a mortgage, avoid at all costs letting the repayments exceed 30% of your income.
12. Credit cards
Credit cards can be a cancer for our personal finances, but on the other hand some of them also come with rewards.
The truth is there’s nothing wrong with using credit cards as long as you pay off the full balance every month. Under no circumstances fall into the trap of buying something on a credit card and paying only the monthly minimum (financing the purchase), because that interest is devastating for our finances.
13. Track your spending
We can’t improve if we don’t know what we can improve. And we can’t manage what we can’t measure. You need to know at all times where the money you spend is going. Only then can we start working out where to cut back and what we can solve more cheaply. We gave some tips for living a more frugal lifestyle.
14. The idea of paying yourself first
The general public has this idea badly twisted. What it really means is that as soon as you receive your salary or income, you first take the money you’ve earmarked for saving, then you pay the month’s bills and instalments, and whatever is left you can spend on leisure.
Most people do it the other way round. They get paid, they pay bills and spend money, and if there’s anything left at the end of the month, they save it. Unfortunately for them, there usually isn’t anything left to save at the end of the month, because they have no budget and don’t track their spending.
One way to avoid this is to automate your savings with your bank. In other words, as soon as your salary comes in, the bank automatically moves a set amount into a savings account. That way, at least, we know that money is off limits.
15. How much money should we save each month?
The answer to this question is simple: the more the better. To avoid many common personal finance mistakes, such as spending more as soon as you earn more, you need to set a fixed savings percentage. That percentage should be at least 20%. So if you earn €1,000, you should save €200. That way, if one month you earn €2,000 and stick to saving 20%, that month you should save €400.
This approach needs to be followed to the letter: if we earn more, we can spend more, but ideally the savings percentage should stay the same.
We say a minimum of 20%, but the ideal is 30%, and without a doubt, the people who reach financial freedom quickly save as much as 50 or 60 percent of their income.
And those, basically, are some easy-to-understand points that are the starting point for healthy finances.
Featured image: Wainuiomartian, CC BY-SA 4.0, via Wikimedia Commons.
